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By Negotiation vs By Payment in LC

By Negotiation: Let's say you are an exporter from India, selling textiles to a buyer in Germany. The buyer's bank in Germany issues a Letter of Credit (LC) payable "By Negotiation". You ship the textiles and submit the necessary documents (like a bill of lading, commercial invoice, etc.) to your bank in India. Your bank verifies these documents, forwards them to the buyer's bank in Germany, and pays you immediately for the goods because the LC is "By Negotiation". The buyer's bank will later reimburse your bank once it verifies the documents and receives payment from the buyer.

By Payment: Now consider the same scenario, but the LC is payable "By Payment". You ship the textiles and submit the necessary documents to your bank in India. Your bank checks these documents and forwards them to the buyer's bank in Germany. But this time, your bank doesn't pay you immediately. Instead, it waits for the buyer's bank in Germany to verify the documents and receive payment from the buyer. Only after the buyer's bank has paid your bank, your bank will pay you for the goods.

In both cases, the LC acts as a guarantee of payment, but the timing and process of payment differ. In "By Negotiation", you get paid immediately after presenting the necessary documents to your bank, while in "By Payment", you get paid only after the buyer's bank has received the payment from the buyer and transferred it to your bank.

"By Negotiation" is generally better for the exporter, mainly for two reasons:

Speed of payment: With "By Negotiation", the exporter gets paid immediately after presenting the necessary documents to their bank. This can significantly improve the exporter's cash flow situation, which is often crucial in international trade.

Reduced credit risk: Since the exporter's bank pays immediately upon presentation and verification of documents, the exporter does not need to worry about the financial stability or creditworthiness of the foreign buyer or their bank.

However, whether "By Negotiation" is actually available to the exporter can depend on several factors, such as the terms of the LC, the policies of the banks involved, and the specifics of the export transaction itself. It's also important to note that the "By Negotiation" LC generally involves higher fees than the "By Payment" LC due to the increased services provided by the bank.

Therefore, while "By Negotiation" is typically better for the exporter, it's crucial for exporters to understand the terms and conditions of their specific Letter of Credit and to consult with their bank or a trade finance expert if necessary.

The main disadvantage of the "By Payment" method from the exporter's perspective is the delay in receiving payment. With "By Payment", the exporter's bank waits for the buyer's bank to make payment before releasing funds to the exporter. This can lead to a significant delay in payment, which can strain the exporter's cash flow and potentially cause financial difficulties.

Here are some reasons why "By Payment" might be less preferred than "By Negotiation":

Delayed payment: With "By Payment", payment is made only after the issuing bank (buyer's bank) receives the payment from the buyer and transfers it to the nominated bank (seller's/exporter's bank). This might take more time than "By Negotiation", where the nominated bank pays the exporter immediately upon checking the documents, before it receives payment from the issuing bank.

Higher credit risk: The delay in payment can increase the credit risk for the exporter. If the buyer or the buyer's bank runs into financial difficulties before payment is made, it could lead to non-payment.

Cash flow difficulties: The delay in payment can also lead to cash flow issues for the exporter. In many cases, the exporter has already incurred costs to produce and ship the goods and may need to be paid promptly to recover these costs and maintain their business operations.

In general, "By Negotiation" is often seen as more advantageous for the exporter because it reduces payment delays and lowers credit risk. However, the choice between "By Negotiation" and "By Payment" will depend on various factors, including the terms of the LC, the relationship between the exporter and the buyer, and the policies of the banks involved.

When dealing with 'By Negotiation' and 'By Payment' in Letters of Credit (LCs), exporters must consider the following practical inquiries:

Which type of LC is more suitable for my business model? Consider your cash flow needs, your buyer's creditworthiness, and your risk tolerance.

What are the specific terms of the LC, and how might they affect my business? Ensure you understand the details, including when and how payment will be made, and what documents are required.

How reliable is the buyer's bank? Your payment is ultimately dependent on them, so their creditworthiness matters.

How familiar is my bank with handling LCs, particularly 'By Negotiation' LCs? Not all banks have substantial experience in this area, so you'll want to choose a bank that knows what they're doing.

What are the fees involved in each type of LC? Different banks might charge different fees, so be sure to clarify this beforehand.

What happens in case of a dispute? Understand the processes and safeguards in place in case something goes wrong.

Working with a knowledgeable export-import consultant like Barai Overseas can give you the confidence to expand your business internationally, knowing that you have a trusted advisor to help you navigate the complexities of international trade. 

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